TFSA or RRSP Decision Guide Infographic

January 4th, 2016 by Potato

Tax-Free Savings Accounts (TFSAs) and Registered Retirement Savings Plans (RRSPs) are great ways to let your investments grow tax-free — with the added benefit of making your paperwork simpler because you won’t have to track or report the gains of individual investments within them. Deciding which is best for you can be a bit complicated, so this decision tool should help you quickly figure out which to use, with some additional discussion below. Click here or on the preview image to open the PDF.

A decision guide in PDF format to help you decide whether to use your RRSP or TFSA. Click to download.

TFSA: The TFSA is a very flexible tax shelter, and also very straightforward. Everyone over 18 gets the same amount of contribution room each year. You put in money that you’ve already paid income tax on (“after-tax contributions”), your investments grow tax-free, and there’s no tax paid on withdrawals. What really makes the TFSA flexible though is that you can add back any withdrawals you make to your next year’s contribution room, so if you find you need access to your funds it’s easy to get at them and then catch up on your savings and get back on track later.

RRSP: The RRSP is a bit more complicated. It also shelters your investments from tax as they grow, but starts with pre-tax money (you get a deduction for contributions), with the withdrawals eventually added to your taxable income. If your tax rates when you contribute and withdraw are the same, the benefit is the same as that of a TFSA, and if you can withdraw at a lower effective tax rate than when you contribute, the RRSP can provide a bonus benefit on top of the tax-free compounding — but predicting if those tax rates will be different (and whether that will be beneficial to you) can be a bit tricky. Everyone has their own RRSP contribution amount, based on how much was made in the previous year along with adjustments for participating in pension plans. While we tend to think of the RRSP as an account strictly for retirement, there are programs for making withdrawals (loans) from your RRSP to buy a house or go back to school (the Home Buyer’s Plan [HBP] and Lifelong Learning Plan [LLP]). You can also make a withdrawal at any time for any reason, but will have to add that amount to your taxable income — and you won’t get the contribution room back.

Both: Both can hold a wide variety of investments, from savings accounts and GICs to mutual funds to stocks and exchange-traded funds. Both shelter your investments from taxes (and the associated reporting/tracking requirements). In all cases, if you have the room holding your investments in a TFSA will be better than non-registered (taxable) account. In most cases an RRSP will also be better than a taxable account, but when the taxes at withdrawal will be much higher than those at contribution (high enough to outweigh the benefit tax-free compounding), a non-registered account may be preferable. For example, if you expect to withdraw from an RRSP in retirement where it will cause GIS claw-backs, you may be better off with a non-registered account if your TFSA is full. Likewise, if you’ll need near-term access to your funds, a non-registered account or TFSA may be better than an RRSP.

If you don’t have money to contribute now, both the RRSP and TFSA let you carry your contribution room forward until you can use it.

So to help you decide between these two good options, here are some considerations, in order:

1. Default Option

The TFSA is flexible and easier to use, so if you don’t have the time to figure it out exactly, or lack some information on your current and future tax situation to optimize, go with the TFSA — you can always withdraw from your TFSA and switch to an RRSP later. The is also a good default option because the TFSA tends to be better for people with less money, but those in situations where they might prefer the RRSP (through the other steps below) will often have enough more than enough money to max out the TFSA, so starting with the TFSA will still lead to having investments in both.

2. Emergency Access

Any money you’ll need in an emergency has to be accessible. Have a cash emergency fund, and if you fill your TFSA keep that emergency fund in a non-registered (regular) savings account. But also consider keeping some of your long-term savings accessible in your TFSA, just in case you need more than your cash emergency fund. If you have to sell and withdraw some investments, there will be a lot fewer complications and you’ll get the room back if they’re in a TFSA. If everything is locked up in an RRSP it can add more stress to an already-stressful situation. So if you’re just starting out with your long-term savings, it can make sense to start in the TFSA regardless of other considerations just in case your planning for the long term was off or something unexpected comes up.

3. Free Money

Always take free money when offered. If your employer matches your RRSP contributions, sign up for that program, as that benefit will almost certainly outweigh any other advantage a TFSA might hold.

In some cases this may also point you towards making RESP contributions a priority, but that’s getting beyond the scope of this guide.

4. Behaviour

RRSPs can only beat TFSAs if you’re making RRSP contributions pre-tax. That means that you’re contributing the refund too, or having your contributions come straight off your paycheque with the tax withheld reduced — either way, you have to put more in the RRSP in the first place for it to equal out. Though more dollars go in, because it’s pre-tax it has the same effect on your after-tax spending dollars. If you would contribute the same amount you’ve saved up at the end of the year in either case and then fritter away your refund in the spring, go straight to the TFSA.

However, behaviour can also point you in the other direction: if you need your funds to be as locked up as possible to protect you from yourself in a weak moment, you may prefer the RRSP over the TFSA.

5. Low Income

If you’re lower income (less than about $40k/yr — in the lowest tax bracket), then look towards the TFSA. In particular if you may be eligible for GIS in retirement, the claw-backs from RRSP withdrawals will be a big disadvantage, and the TFSA will be better for you. Remember that claw-backs of these programs is part of your overall effective tax rate to consider when looking at the RRSP’s tax arbitrage ability.

6. Special Situations

Buying a house? The RRSP HBP lets you use pre-tax money for your down-payment, which cam help you avoid CMHC fees. If you already have more than enough saved up to put 20+% down no matter which tax shelter you use, then you may not care, and may even prefer the flexibility of the TFSA. But if you’re just under that mark, being able to put pre-tax money (i.e. your savings plus a refund) in an RRSP and then withdraw all of that (including the government’s portion) can help get you over the line and save a lot on CMHC fees.

Another special situation that might favour the RRSP is a gap in earnings, such as going back to school or an upcoming mat/pat leave. Having significantly lower earnings in a year may let you use tax arbitrage early, though you won’t get the contribution room back. Keep in mind that your taxable income is calculated by calendar year, so a leave starting or ending partway through the year may not bring your earnings down far enough for this move to be advantageous.

7. Tax Arbitrage

Most comparisons skip straight to this step, but it’s important to understand that the above factors can be more important than the math. However if there are no over-riding factors influencing the decision, then the RRSP will be better than a TFSA for people who have a lower effective tax rate when withdrawing (usually that’s in retirement) than in their contribution years. The TFSA will be better in the opposite case, where the tax rate is lower in the contribution years. Note that the withdrawals may move you up through several tax brackets if a large part of your retirement earnings come from your RRSP, so the average benefit may be there even if the last few marginal dollars are in the same brackets. Don’t forget the effect of clawbacks on government benefits (like GIS and OAS). Predicting your future tax rates (and how they compare to where you’re at now) can be a tough exercise given all the uncertainties of the future (not only your own earnings situation and the performance of your investments, but changes to the tax rates themselves by future governments), so this may be one to work through with the help of your planner.

Many people will end up using both accounts to an extent.

I’d like to thank Sandi, Dan, and Wayfare for feedback on early versions of the tool.

Book Anniversary and 1000 Sales!

November 30th, 2015 by Potato

The anniversary of the release of The Value of Simple is tomorrow, and I’m excited to say that it has just rolled past 1000 sales!

I honestly didn’t think it would hit that point and hadn’t written anything ahead of time, so in brief: hurray! I can’t believe it’s come this far, especially given how much I suck at marketing. I love seeing all those positive reviews and people referring it to their friends, and that even after a few months it’s still fully checked out at the various library systems that have it across the country, with a backlog of holds in Toronto and Vancouver!

In the meantime, I’ve been working on something that I knew would take forever and is taking even longer — I thought maybe if I pulled a few all-nighters I could get it out for the close of Financial Literacy Month (today), and now I see it’s going so slow I may have to re-think the whole idea.

Speaking of Financial Literacy Month: hey, if you’ve just learned how to budget and save your money, why not check out The Value of Simple, a really easy-to-use guide that will help you take the next step to investing that money you’re now saving?

And speaking of holidays, it also makes a great gift. So many people out there could use a little more financial literacy and investing how-to, but may not even know to look for it themselves. And it’s slightly more exciting than socks (there’s a bunny in it!). If you’re just looking to pick up a copy for a gift then there are lots of ways to do that. Both Amazon and Indigo have been discounting it online (if you buy enough other things to qualify for free shipping, it’s actually cheaper for you than buying from me directly), so that may be the way to go as long as those price cuts hold. If you want a signed copy though you’ll have to order directly from me. The last day to order and expect Canada Post regular delivery* in time for xmas is December 16 (December 17 for Ontario addresses) — the retailers will have their own shipping cut-off deadlines.

* – XPressPost cut-off would be Dec 21, but that will cost $17 extra — more than the book itself!

Exciting Book and Podcast Updates

November 5th, 2015 by Potato

First off, I had two recent podcast appearances:

Over at Because Money, we talked about who should be a do-it-yourself investor, related to this post. Interestingly, after we recorded this we got to hear more about the importance of behaviour at the Canadian Personal Finance Conference, where the final talk by Dan Bortolotti indicated that because of self-defeating behaviour he doesn’t think many investors should be do-it-yourselfers. I tried to emphasize behaviour and processes in the book to make sure that people didn’t fall into those traps, and I plan to focus my efforts for the rest of the year on solving that problem so that more DIYers will be successful.

Then, I was on the Mo’ Money Podcast, talking about the book and my history with money.

If this is your first time finding out about the book, or if you have someone you think should pick up a copy to learn about investing, then be sure to head on over to Amazon — it’s on sale at the moment for an incredible price. I’m not sure if it’s a financial literacy month thing (aka “November”), or if it’s a flash sale that will be over tomorrow.

I also want to excitedly say that my October sales numbers are in and the Value of Simple now sits at 956 sales. It’s totally feasible to get 44 sales in November (the financial literacy-est month of the year!) to manage to roll over 1000 the sales mark by the 1-year anniversary of the book’s release in December! Totally feasible with your help that is. Remember that most people you know and love likely don’t know anything about investing or a lot of other financial topics — Kyle called it the “Canadian emperor has no clothes” phenomenon in the podcast, where everyone assumes everyone else has this all figured out and doesn’t want to talk about it. So be sure to whisper it in their ear, or send them a link to buy the book (or at least check out the reading guide), or just buy a copy for them now for Christmas to help me reach my completely arbitrary goal!

Finally, if you’re interested in a bulk order (for instance if you want to get your clients or employees something awesome and educational for the holidays), the printer has reminded me of the various ordering cut-offs for shipping in time for Christmas, as well as an extra discount for orders (over 10) placed before Nov 22. Contact me for details about bulk orders.

Non-Registered Investment Tracking Spreadsheet

September 8th, 2015 by Potato

In a non-registered account you will at some point have to pay tax on any capital gains, and you have to report that amount yourself. You’ll need some method to properly* track your cost base so that when you sell you know how much of a gain (or loss) to claim on your taxes. [TL;DR — click here to download the spreadsheet]

I often get asked whether tracking ACB yourself is really necessary. Brokerages and mutual fund dealers will track your book value for you, and most of the time they’re accurate. So you could save yourself a fair bit of effort by just relying on their calculation for tax purposes, especially if all of your accounts are in one place. However, if you have holdings of the same ETF/stock/fund at different brokers (e.g., if I had an account at TD Waterhouse holding VDU and one at Questrade holding VDU) then they wouldn’t talk to each other and there would be no option other than to track it myself. They also don’t seem to catch superficial losses. The bigger issue though is that the brokers sometimes make mistakes in the book value calculations, and it is ultimately your responsibility to report correctly to the CRA.

So the only proper advice I can give is to carefully track it yourself to double-check your broker/mutual fund dealer because the onus on being correct will fall on your shoulders. But that said, I do personally know a few people who do not track it themselves and who come out fine (either because the broker/dealer gives them correct information, or because even when there are errors they don’t get audited) — in the real world it’s very tempting (and understandable) to take the free tracking offered. With mutual funds there’s one less step for information to go wrong (at least if you’re buying funds from the issuing company, like TD e-series at TD), so it’s even more likely to be correct, but you’ll never know if you’re the one unlucky customer with a bad book value calculation until you get audited. And of course, the errors they’re making could be costing you money. If you do let the company track for you, at least be sure to hold on to the statements you’ll need to re-do the calculation if it comes to it.

Tracking it is not all that hard a mathematical exercise, the tricky part comes in being careful to put everything on the right side of the ledger and to follow-through each year. There can be a lot of transactions to put in there, including annoying “phantom” distributions that change your cost base but didn’t actually show up in your brokerage statement. There are a number of tools out there to try to help you with your ACB, including a web-based calculator and spreadsheets from several sources, like this classic (if sparse) one from the old Canadian Capitalist blog.

I myself use a very barebones spreadsheet similar to CC’s, but it’s not a great model for others to use because it depends on me knowing what it is I’m doing with the ACB calculation to create each new row as needed.

So I’ve created a new template that I hope is better suited to the target audience for the Value of Simple (click here to get the sheet). This sheet assumes that you’ll have a fairly typical experience of buying/DRIPing many shares/units over time, and only occasionally selling. So rather than save space and intersperse all the transactions as they happen, it’s set up to go with your workflow. I assume that you’ll go through various modes. First you’re buying and holding, then it summarizes your ACB for a sale with all the adjustments from RoC and reinvested capital gain distributions, then you make a sale (or series of sales), and then get back into buying mode. Then each of your funds gets its own tab.

As with many ACB trackers, the superficial loss rule can throw you for a loop. It’s hard to catch everything that can trigger a superficial loss, so there is no automatic check for it so you won’t have a false sense of security — you’ll have to catch those situations yourself (though there is a sample of that case so you can see how to adjust your cost base for when it does happen).

* – I often stress the importance of tracking this yourself. That’s because it’s so tempting to not track it properly and independently and rely on the “book value” or “cost” listed on your brokerage statement. Most of the time this will be correct and you could have saved some record-keeping effort. However, sometimes it won’t be, and then you’ll be mis-reporting to the CRA. It’s analogous to tracking your TFSA contributions yourself: the CRA online tool or phone reps may be able to accurately tell you how much room you have left, but in the rare case where that’s wrong the penalties will still fall in your lap. So I’ll try my best to tell you how to track and report properly, and make it as easy as possible; if you choose not to and get audited, at least you’ll know what you did wrong!

Gearing up for Word on the Street

September 7th, 2015 by Potato

Word on the Street is just three weeks away, and I’m excited to have a booth there this year, where I’ll be hawking the Value of Simple (the booth will be called Simple Investing).

It’s tough to estimate how many copies I’ll need on hand, so I just figured that if I sold a copy every five minutes I’d be doing pretty well, did the math, and will arrive with just under 100 copies. Running out would be a good problem to have, so I’m hoping that it turns out to be a conservative estimate — but if I’ve over-estimated, expect a sweet sale for xmas orders this year.

I’m gearing up for it in other ways too. While I’ve long been with PayPal to accept credit cards for orders through my direct site (and to invoice for credit cards for side business stuff), for this kind of event I wanted to get a mobile card reader to take payments on-site. I was briefly excited to see that PayPal had one called PayPal Here — and it even supported Windows tablets! — but then saw that they don’t like Canadians and I had to go find someone else until some indeterminate future date when the rollout came north of the border. Intuit has an option for Canadians, but only works on iOS devices. That leaves Square1, which I had actually heard of and knew as the little start-up that kicked off the use-your-mobile-phone-to-take-credit-cards business. Though they don’t support Windows tablets or Blackberries (the devices I will have on-hand at WotS), they did support Android, and Wayfare is currently shopping for a new cell phone and will likely go Android.

I have to say I was impressed with the whole process — easy to sign up, and the hardware is tiny and light and arrived in just a week. Thanks to this thread at CrackBerry I was able to get the app working on my BlackBerry (which does run many Android apps — getting them on is usually the tricky part), and have charged myself a $1 sample transaction just to see how it worked. Other than having to sign with my finger (no pen or stylus I have seems to work on the BB’s screen), it was incredibly smooth and easy. As an aside, given that new BBs run Android apps, I’m surprised companies with apps like this don’t bother to port their apps over so us dinosaur BB users can download them without workarounds. I know we’re a small and dying breed, but it’s not nothing.

Other than that I’m trying to come up with all the material I will want at the booth to give away and help with promotions. I’ll be bringing along some hardcopies of the reading guide, which makes me wish I had designed it for standard print sizes instead of for screen display. Bookmarks tend to be a standard thing, but I’m not sure what to put on mine that would make it useful or stand out against a sea of hundreds of other bookmarks (maybe one of the comparison tables? “Don’t Panic”?).

Wayfare had a great idea to take advantage of the family-oriented nature of WotS: have stickers for the kids and RESP info cards for the parents, so I’m working on the design for that, with not much time left to send it to a printer and get it back before the big day!

Readers, anything else you think I should include? Or is this getting to be too many little bits of cardstock at the table?

1. This is an affiliate link, but that didn’t affect my review of Square. If you use this link to sign up they’ll waive my credit card processing fees, but if you do so after WotS it’s likely that will be of no benefit to me anyway.